Tuesday, 22 July 2014

Is economics jargon distortionary?

Employees are already beset by red tape if they try to improve
their working conditions. Now the UK government wants to increase the regulatory burden on
them further, by proposing that employee organisations need a majority of all
their members to vote for strike action before a strike becomes legal, even
though those voting against strike action can still free ride on their
colleagues by going to work during any strike and benefiting from any
improvement in conditions obtained. Shouldn’t we instead be going back to a
free market where employees are able to collectively withhold their labour as
they wish?

I doubt if you have ever read a paragraph that applies language
in this way. Yet why should laws that apply to employers be regarded as a
regulatory burden, but laws that apply to employees are not? Labour markets,
alongside financial markets, are areas where the concept
of a ‘free’ market uncluttered by regulations is a myth. Here, as elsewhere, language has been distorted to suit
a neoliberal agenda.

Is this also true with terminology used in academic economics?
That is the argument put forward by Charles Manski in this Vox piece in the context of economists’
discussion of taxation and lump-sum
taxes. He writes:

“Students of economics learn that the formal usage of the
concepts 'inefficiency', 'deadweight loss', and 'distortion' in normative
public finance refer to a theoretical setting where a private economy is in
competitive equilibrium and a government can use lump-sum taxes to modify the
endowments of individuals. In this setting, classical theorems of welfare
economics show that any Pareto efficient social outcome can be achieved by
having the government use lump-sum taxes to redistribute endowments and
otherwise not intervene in the economy. Income taxes and other commonly used
taxes logically cannot yield better social outcomes than optimal lump sum taxes
but they may do worse. Deadweight loss measures the degree to which they do
worse.”

The big problem with this terminology and associated research
agenda, he argues, is that it presumes lump sum taxes are a feasible option,
whereas in reality they are not.

“The research aims to measure the social cost of the income tax
relative to the utterly implausible alternative of a lump-sum tax. It focuses
attention entirely on the social cost of financing government spending, with no
regard to the potential social benefits.”

Indeed, lump sum taxes (a.k.a. a poll tax) are not a feasible
option precisely because they achieve non-distortion at the cost of being
unfair, and in the real world taxation is as much about fairness as allocative
efficiency.

The counterargument is that the idea of a lump sum tax is just
a useful analytical device, which allows research to focus on the taxation side
of the balance sheet, without having to worry about what taxes are spent on. It
would be equally possible to look at the benefits of different types of government
spending, all of which were financed by a lump sum tax. Equally the competitive
equilibrium against which real world taxes are distortionary is an imaginary
but analytically useful reference point - everyone knows the real world is not
like this competitive equilibrium.

It is not our fault, the counter argument would go, that
non-academics abuse these analytical devices. No serious economist would talk
about the costs and benefits of a policy
to cut a particular tax in isolation, when that cut has been financed using a
lump sum tax. Governments that do that have clear ulterior motives. Equally no
serious economist would talk about the benefits of reducing a tax designed in
part as Pigouvian (i.e. a tax designed to offset some market externality), within
the context of a model that ignores that externality. (For a recent example
where the UK Treasury published a study that managed to do both of these
things, see here.)

I think the key here is to clearly differentiate analysis from
policy advice. I have used lump sum taxes in my research, and I often talk
about taxes being distortionary. I think both general and partial equilibrium
analysis is useful, and devices that allow abstraction are invaluable in
economics. (I have less sympathy for the concept of Pareto optimality, for
reasons discussed here. See also the excellent series of discussions
by Steve Randy Waldman.) However these devices can often allow those with an
agenda (including the occasional economist) to mislead, which is why economists
need to be very careful when presenting their analysis to policy makers, and
why they also need to have the means to alert the public when this kind of
deception happens.

This sort of reminds me of the turn towards post-structuralism in the humanities in the 1970s. (Follow me on this, it's a stretch.) After the failure of the 1960s to be more revolutionary - the failure of May 68 in France, etc. - some in the humanities profession turned inwards to the imperfection of language, like Derrida. With better theory and a better understanding of language they could understand the failure.

Likewise the heterodox are blaming the orthodox's theory when as Wren-Lewis and Krugman point out, it's the implementation that is often the issue. Sure the theory can be easily bent, but it's easy to see when it is being bent if one has the minimum critical thinking skills.

The heterodox may have a point over which theories, models or mechanisms are emphasized. It may be as simple as that orthodox theory presents periods of demand shortfall as historically or theoretically no more prevalent than periods of supply-contrained. Whereas history tells us that periods of demand shortfall are more the rule than the exception.

"Robert Lucas (2003): Chicago Follies (IV): "Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades..." Via Lars P. Syll"

What I want to know is what "the problem is implementation" means. Krugman has explained that his implementation is ad hoc and is guided by "no logical principles" (Paradigming is Hard). So, by definition, there's no way to know if you're doing it wrong. And, of course, for every situation there is a way to get "the right answer" that can be called "consistent with textbook economics".

Indeed, there is persistent double think, leading to double talk, in economic discourse. This is both in the popular and 'intelligent' press, where the motivations are often clear if you want to look, but also, I am coming to believe, embedded in the structure of economics as a discipline.

If you set up the parameters of the subject on the basis that the major problem is scarcity, so more is always better and that the individual is supreme so more choice must be better (as my Cambridge economics course did more than 40 years ago) then even the most socially aware student and teacher (and there were plenty) is going to find the terms of debate push only one way.

This struck me very forcibly some 16 years ago when I participated in a post-graduate discussion on the Rio environmental agreements. The well respected, and in US terms liberal, professor leading the discussion explained that there was no way that the US would ever accept the proposed measures because they would tend to reduce GDP (by his calculation) by 1.5% per year.

When I suggested that this suggested a problem with the calculation of GDP the remark simply did not compute: I was attempting to subvert the principles of the profession (I exaggerate rather).

You still hear - a lot - this critique. We must frack or exploit shate oil or GDP will suffer. Or, to get away from the environment, we must reduce labour standards because otherwise income will fall. There is something deeply wrong if the basis of our mode of thought (which I have been proud of all my working life) leads us to promote earth- or people-destroying policies.

As Francis Bacon might have put it: The natural sciences, which grew out of philosophy and technology, attempt to discover the order in things. Economics, which grew out of political arithmetic and cameralism, imposes order on people. Science is about knowing, economics about administrating. The former uses reason to understand while the latter rationalizes domination. Scientists are the servants of truth. Economists are the henchmen of power.

The main problem of economics (as 'science' studying economics as way in which people organise their provision for their wants and needs) is rooted deeper than in jargon (incrowd language), I think.Its roots date back to the 19th century, when classical economics developed into neo-classical economics in response to marxism and nations developed representative party democracy in response to labour emancipation.

The problem is the basic model (understanding) of economics (the 'reality' being described and explained) as based on 'markets', with government as way of organising things that is only second-best (and therefore usually described as 'government intervention').The problem is not even primarily that government is second-best (an understanding that is shared between orthodox AND most heterodox economists), but dichotomic thinking and understanding: either 'markets' (usually connected with the adjective 'free') or government (usually understood as 'imposition from outside' of rules and conditions).Within ALDE, the family of liberal political parties in the European Union, an alternative way of understanding economy and society has been developed: as organised by 3 rather than 2 fundamentally different governance principles.See "Governing governance" (www.aldeparty.eu/en/news/elf-launch-new-essay-pamphlet-governing-governance).That disctinction in 3 can be linked to the distinction in 4 that I developed in my "Economics of want and greed" (www.antenna.nl/wim.nusselder/schrijfsels/economics.htm)Both can be used to undo this 'political capture' of economics dating back to the 19th century.

The core concepts of contemporary economic theory include individual preferences and constraints, but not markets. Markets and their structure partake to the category of environmental parameters and, as they are commonplace in our societies, they are more than necessary as components of our models. What I am trying to say here is that I wouldn't expect scientists to develop models that do not include a setting for transactions when most of the decisions that are relevant to their theory take place in such a setting.

Of course, one might wonder if presenting things as economist do might not proceed from some worldview, or if it would at the very least limit what sort of views might be thought of as sensible in the sense of being coherent with our theories. In this specific sense, I welcome your criticism: presenting so many interactions as consensual exchanges does seem to taint the world with intentions and purposes that aren't in themselves necessary to do science -- and, which, might very well serve a political agenda at the same time. As we might say, it's as if they're pointing only at the convenient stuff.

But, with that said, economic theory also applies to other circumstances. The basic idea is that agents always select their preferred consumption basket among those that are available to them, given the limitations they face and the environment in which they operate. This approach must also make sense of "non-market" decisions because, if you did not realize it yet, it is an arbitrary conceptual division. The real science and the real explanation still lies ahead: it's only once you tell a story about preferences and constraints for many people in one specific context that you have something we can consider to be an explanation. To get back to "non-market" interactions, I must include here the classical examples of love and friendship. Befriending someone, just like buying an apple, can be thought of as the expression of personal preferences while under constraints.

But why the "confusion" then? Why would people not think of such analysis to be possible? You're certainly not stupid and neither are you the first to bring such critics, so where's the problem? I believe that part of the problem lies in what you find in introduction textbooks. The models you find in these books are typically unrealistic -- and for a good reason: economics courses are not applied mathematics courses. To make sure students do not waste time figuring out the solutions to annoying mathematical problems, they provide them with problems whose solutions are simple -- so simple you have to make these problems silly. In reality, consumers dot not merely face a budget constraint; they also face social constraints and cognitive constraints. If you want to go further, they actually have troubles transferring income between different periods: e.g., bankers seldom lend to students against a promise that they will be well paid once they become medical doctors. These are just a few things, but they can make big differences in how agents behave -- in these case, by changing the consumption baskets agents deem accessible.

The other problem might be found in the academia. It might be hard to find research on friendship made by economists, but it will be easy to find research about monetary or fiscal policy, or about oligopolies. Anyhow, if you are not sufficiently acquainted with economic theory, these biases can mislead you easily into thinking economics is an expression of right-wing bias in social sciences -- when, in fact, it is not.

Of course, some "lump=sum tax advocated do not presume that the tax needs to be the same for everyone. After all, given perfect knowledge of everyone's utility functions, we could set the (individual) taxes so that they have the same utility effects. This (presumably) means higher taxes on people with higher income (or wealth)...Oops.

Even if you had perfect knowledge of people's preferences as you hypothesized, this would still not be enough to be able to proceed with your plan of affecting everyone the same way.

Utility is an ordinal concept meant to translate in mathematically convenient terms preference relations. That is to say, by attributing values to consumption basket, you can reproduce a list of such baskets, going from best to worst with possible ties. But, in doing so, you need to understand that the attribution of values is more or less arbitrary since the only thing that matters is that the list remains the same, whether you use utility functions or proceed directly from a totally pre-ordered set. As I said, utility is an ordinal concept: it serves to rank stuff, not to compare them.

To take a precise example, use a simple, though unrealistic utility function: the Cobb Douglas. Say we have agent A with preferences being U(x,y) = (x^3)(y^2). For the basket (1,1), we get U(x,y) = 1; and for (2,2), you get 32. So, A prefers (2,2) to (1,1). But, as I told you, it's the order that matters and we can represent these same preferences with another function: U(x,y)=3(x^3)(y^2). If you verify, the first basket scores 3 and the second one scores 96. Multiplying by any positive constant is a monotonically increasing transformation; it leaves the rankings intact.

So, you have a problem here: how do you compare between individuals when all this allows you to say is that a tax deprives the agent of a basket he preferred to the after-tax basket? You have no way of measuring the difference because utility is ordinal. Furthermore, nobody knows how to compare preferences between people. Should we proceed one-for-one as utilitarians suggested in their ethical philosophy? Or maybe are there people for whom a loss is worst than for others? I don't know.

So much gobbly-gook here. Science has nothing to do with models as economists use the term. You start with observations, you come up with a way to make sense of the observations and then you see if the implications of that "way of making sense" are also true in the world. Calling that "way of making sense" a "model" or "theory" leads to endless semantic confusion of the kind seen here.

If you don't start with data first and then try to find regularities or other "ways of making sense" you're not doing science. You're not doing social science. You're doing Sudoku.

"The suggestion that we should not worry about national inequality because global inequality has fallen is even more bizarre. "

Good point. But there is more to this. If economists had also been paying attention to a lot of debates outside the immediate mainstream over the last decades they would also know something about global inequality. True, more people have been lifted out of poverty (thanks mainly to China and East Asia and the deft and careful way they have managed their entries into international capitalism - unlike the ex-Soviet Union which immediately liberalised capital and trade flows).

But the GAP between the richest and poorest has increased.

Why?

Because a large section of the world's population - especially in Africa and the Middle East has been left behind.

This is behind social and political fragility in these countries- and is a problem for all of us. You could argue their plight has got worse over the last three decades. We have a classic poverty trap.

So again, it depends on the measure of inequality.

More important it highlights the needs for mainstream economists to listen to people who are outside their profession who are working closely with people on the ground who understand these societies.

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